Among the numerous provisions contained in the Coronavirus Aid, Relief, and Economic Security (CARES) Act legislation, an area of interest to the real estate industry pertains to a correction of an inadvertent exclusion of Qualified Improvement Property (QIP) from the list of assets eligible for bonus depreciation.
The Treasury Department also recently issued additional guidance, including the ability for a partnership to amend a prior year return, as well as the revocation of certain elections that were not previously revocable.
Below is a brief summary to provide tax return preparers of calendar year 2018 and 2019 tax returns with explanations and comparisons to identify potential scenarios where discussions with advisors may be warranted.
Qualified Improvement Property (QIP) - Background
The Protecting Americans from Tax Hikes (PATH) Act of 2016 created QIP to expand types of property that qualify for bonus depreciation.
The Tax Cuts and Jobs Act (TCJA) of 2017 included a technical error, which made QIP ineligible for bonus depreciation and accelerated depreciation, thereby relegating QIP to recovery over 39 years.
The CARES Act fixes the TCJA technical error by:
- Assigning QIP with a 15-year recovery period;
- Making QIP eligible for first-year bonus depreciation; and
- Retroactively making the corrections back to TJCA 2017.
What qualifies as QIP?
- Interior improvements to a building that is nonresidential real property;
- Eligible improvements placed into service AFTER a building was originally built;
- QIP exclude costs for building structure, elevators or escalators and building enlargement;
- The lease agreement does not need to be between unrelated parties; and
- Unlike QLI or QRP, there is no three-year requirement.
Qualified Improvement Property (QIP) – Areas for Consideration
Q: Did the entity have any QIP in 2018?
A: Since 2018 was the first year in which QIP could have been placed into service with a 39-year life under the TCJA, under the CARES Act there could be a savings opportunity (see example below). Property owners should identify these entities for further discussion.
Q: Did the entity place into service any QIP in 2019?
A: Consideration should be given to whether the return has been completed or filed. If so, discussions are needed to determine whether current year changes could be made. Similarly, identify those returns that have not been finalized for potential impact and rework.
Q: Has the entity made an excepted business election under IRC Section 163(j)?
A: An election under Section 163(j) prevents an entity from taking bonus depreciation. Under recent guidance from the IRS, these entities may want to consider revoking the election in order to avail themselves of the new rules (other factors must be considered). Whether or not the 163(j) election is made, consideration should still be given in accordance with the above.
If an entity has not made an election under IRC Section 163(j), (a) tax returns for 2018 and 2019 (depending on status of filing) could be amended under Rev. Proc. 2020-23 to retroactively apply the new rules under the CARES Act or (b) a Form 3115 Change in Accounting Method could be filed to apply the new rules going forward. This includes assigning QIP a 15-year life and applying bonus depreciation.
If an entity has made an election under IRC Section 163(j), (a) tax returns for 2018 and 2019 (depending on status of filing) could be amended under Rev. Proc. 2020-23 to retroactively apply the new rules under the CARES Act or (b) a Form 3115 Change in Accounting Method could be filed to apply the new rules going forward. This includes assigning QIP a 20-year life under ADS without bonus depreciation, as specified under 163(j). Additional consideration should be given to revoking a 163(j) election under Rev. Proc. 2020-22 (considering additional facts and circumstances).
Additional considerations must be given to the structure of the entity, as well as the potential downstream impact, to ultimate investors and external entities in a tiered structure. Amending may not be desirable, so a discussion surrounding a “catch-up” adjustment may be considered.
Example: A taxpayer is the owner of a multi-tenant office building. In 2018, the taxpayer paid for improvements made to a tenant space and placed into service renovations of the common area lobbies. In their 2018 tax return, the taxpayer capitalized the tenant improvements (TIs) and building renovations as “building Improvements” depreciable over a 39-year recovery period. After the passage of the CARES Act, the taxpayer files a Form 3115 “Application for Change in Accounting Method,” reclassifying the TIs and the common area improvements as newly eligible QIP, depreciable over 15-years, and eligible for 100% first year bonus depreciation. The change is made by attaching a F3115 to the 2019 tax return, and factoring the Sec. 481(a) adjustment into the taxpayer’s 2019 Federal depreciation. The change in accounting method is automatic and does not require IRS commissioner pre-approval.
Taxpayers should consult with their tax advisors to determine how to best take advantage of these changes as it relates to their specific situations.
If you have any questions about the eligibility of QIP for bonus depreciation, please contact James Su, Real Estate Managing Director.